Two large enhanced note issues linked to S&P 500 signal continued popularity of leverage

By Emma Trincal

New York, June 29 - The recent pricing of two large offerings of enhanced return notes linked to the S&P 500 index suggest that investors' appetite for leveraged products continues to be strong.

In today's choppy market, leverage may come in handy for investors who are uncertain about how much equity prices may continue to rise, sources said.

"I think the market is turning less bullish," said a distributor commenting on both deals.

Barclays Bank plc priced $81.77 million of 0% Accelerated Return Notes due Aug. 31, 2012 linked to the S&P 500. Bank of America Merrill Lynch was the agent.

The notes have three-times leverage with a 15.78% cap and no downside protection, according to a 424B2 filing with the Securities and Exchange Commission. Fees were 2%.

It was last week's top offering.

Separately, JPMorgan sold last week's third-largest deal on the behalf of Deutsche Bank AG, London Branch: $49.2 million of 0% return enhanced notes due July 12, 2012 linked to the S&P 500.

This product has two-times leverage but with a higher cap of 19.76%. Investors are also fully exposed to any index decline.

Fees were 1%.

Huge deals

"These are unbelievable sizes. It's clearly the private banking network. Purely retail," a sellsider said.

Leverage, especially without downside protection, has been the preferred structure so far this year, according to data compiled by Prospect News.

Agents have sold $4.44 billion in 261 deals in this structure type so far this year, or 20% of the total issuance, a 36% increase from last year, according to Prospect News data.

"These huge deals indicate that people obviously continue to be attracted to leverage," the sellsider said.

"Nobody is a super bull anymore. That's why leverage is in demand."

Investors' interest in leverage is seen by some as a positive development.

"People are embracing accelerated return, and that's encouraging," said Samson Koo, managing director, head of derivative products at Advisors Asset Management.

"It shows that investors realize that leverage through derivatives is a more efficient way to use capital.

"Leverage also helps investors express their view.

"They simply need to understand the risks. Here, part of the risk is your cap."

Expressing different views

A market participant said, "Leverage doesn't mean that investors are not bullish. They're just bullish within a range.

"One deal is not better than the other. It depends on how you want to use your capital, and it depends on your market view."

This market participant explained why less leverage meant a higher cap.

"With more leverage, you get more exposure, less brokerage fees. It has a cost, obviously, otherwise the issuer couldn't price it. The cost is usually a lower cap."

The preference for the level of leverage and cap results from the investor's view on the market, he added.

"Suppose you're not that bullish and that you don't think you're going to go through the lower cap anyway. In that case, the three-time leveraged note probably makes more sense," he said.

Capital efficient

Using leverage in general gives investors a more efficient use of their capital, this market participant said.

"Let's say that you want a $200 exposure. Without leverage, you have to put down $200. That's $200 of your capital that's at risk. With two-times leverage, you only have to put down $100. Your capital at risk is only $100. So leverage actually gives you a limited downside. That's why you get capped compared to someone who doesn't lever up."

This market participant noted that using leverage through derivatives, via a structured note for instance, is also more cost-efficient than buying on margin.

"With stocks on margin you have margin costs. You also have margin calls. With a structured product, you keep your note until maturity. Nobody is going to call you," he said.

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